The Cost of Owning a Mutual Fund

Although mutual funds can be a good way to diversify your investments across many securities, it can be an expensive way.   There can be many fees associated with owning a mutual fund, and it’s not always obvious how much you are being charged. The fund’s prospectus is the definitive source for identifying the fees. However, the prospectus can be 50 pages long and if you own 10 or more mutual funds you may not get around to determining the fees associated with each fund.

Many sellers of mutual funds tout them as “no load”. No load means that there is no sales charge paid to a broker. Investors may mistakenly believe that there won’t be any fees associated with owning the fund. But, loads are only part of the story as far as charges go. The key point to remember is that everyone wants to get paid, and your money is the source of that payment. The following fees are generally expressed as a percentage of your investment balance.  For example, if you have $10,000 invested in a mutual fund and there is a 1.5% Annual Expense fee associated with it, you’ll be charged $150 every year. $100,000 translates to $1500 in fees, etc. Here are some examples of fees charged by mutual funds that you may not be aware of.

1)      Redemption Fee – not considered a sales load even though it is deducted from redemption proceeds, just like a sales load.

2)      Exchange Fee – If you transfer from one fund to another you might be charged this fee.

3)      Account Fee – A type of maintenance fee that might be charged if your account drops below a certain dollar value.

4)      Purchase Fee - Some funds charge this fee when you buy their shares. It is not considered a load because it is paid to the fund instead of to the broker.  That’s right, they are charging you for buying their fund.

5)      Management Fee – This fee is paid to the fund’s investment advisor for managing the fund’s portfolio.

6)      Distribution (12b-1) Fees – Used to market the fund to other investors and pay brokers for selling shares of the fund.

7)      Other Expenses – If fees aren’t included in the Management Fees or Distribution Fees categories, they are included here. Examples are custodial, legal, accounting, transfer agent, and custodial expenses.

As you’ve seen, sales loads are just one of 8 potential fees associated with a mutual fund. Mutual funds are required to list these fees in the Fund Prospectus.  The Load plus the first three fees are considered Shareholder Fees and are listed under that heading in the prospectus. Fees 4 through 7 are considered Annual Operating Expenses, and appear under that heading in the prospectus. As the title suggests, they are recurring charges.

Mutual funds will list a Total Annual Operating Expenses item.  Although this helps in identifying a part of the expenses, it only includes the annual operating expenses (items 5, 6, and 7). As an alternative to digging through the fund prospectus, you might want to use the Morningstar.com website. Morningstar not only provides expense information, but rates the funds and provides historical yield information in addition to other important information.

The actual fees charges by mutual funds vary considerably.  I’ve seen the Annual Operating Expenses range from 0.01% to over 2.5%. If you think that all of the funds charging 2.5% have higher yields than all of those charging 0.01%, you’re wrong.   Generally, fees are based on how actively the fund is managed. So a fund that is doing a lot of trading will generally be more expensive to own than a fund that just tracks an index like the S&P 500. Ironically, index funds tend to outperform the more actively managed funds and are generally less expensive to own.

Brycast provides investment advice, as well as financial planning and income tax services. If you would like help setting up a new portfolio, or evaluating a current portfolio please contact us at (512) 293-4170 or via email  to norman@brycast.com.

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